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Railroads to struggle with summer US coal demand

World Coal,

With demand for US coal higher than in recent years due to record-setting cold weather and high natural gas prices, railroads are struggling to ship required amounts of bulk fuel, according to Wood Mackenzie in a new report titled Can railroads meet summer US coal demand?.

The harsh, snowy winter slowed down performance at railroad systems already contending with a record grain harvest and higher demand across various commodities in 2013 into 2014. Ultimately, the impact on coal prices will depend on mine and rail capacity.

"Even if the railroad capacity problem is fixed, mine capacity may not be able to grow fast enough to meet demand," notes Matt Preston, principal analyst, North America thermal coal markets for Wood Mackenzie.

With stockpiles significantly depleted during winter, as a result of railroad performance issues and the railway networks likely inability to increase the rate of deliveries much beyond 2013 levels, it appears likely that coal producing units relying on western coal will not be able to increase their output despite higher demand. Tighter gas markets will place upward pressure on gas prices, further increasing the appetite for coal this summer, even as western coal supplies remain limited.

Wood Mackenzie expects that the impact on coal prices will depend on whether rail or mine capacity is constrained. If rail capacity is constraining then the impact on coal prices will be muted; however, if mine capacity is constrained then coal prices will rise sharply, a distinction that will prove to be critical for coal producers.

Coal demand during summer will be critical

"If rail capacity can't keep up with production levels it's less likely that coal prices will increase significantly as buyers will stay on the sidelines due to delivery uncertainty. On the other hand, if railways can perform, then coal prices should climb dramatically as buyers seek to feed the rise in demand for coal fired generation", explains Preston.

Low stockpiles, constrained rail deliveries, as well as lower production levels are having the strongest influence on coal demand from units relying on coal from the Powder River Basin (PRB.)

The BNSF proposed an increase of about 7% in tonnage over the same period a year ago (24 million short t of July 2013 deliveries), however, Wood Mackenzie's report questions if this will be enough, as providing a service level commensurate with 2013 is not going to satisfy coal demand.

One particular concern for coal shippers is that the number of rail movements in 2013 was at its lowest levels over the last decade due to competition from natural gas, and now that natural gas prices have strengthened there is an expected rebound in coal demand. 

"Coal production will be crucial to gas prices through the summer," highlights Barry Posner, senior analyst, North America gas for Wood Mackenzie. "The required rate of burn during the summer exceeds the rate of delivery even in normal years, and generators will not be able to rely on stockpiles to carry the difference. This will lead to limited coal unit operation, increased gas burn, and potentially higher gas prices."

According to Wood Mackenzie’s analysis, in 2013 natural gas prices averaged US$ 3.78/ million Btu over the last three quarters and formed the fundamental backstop on PRB coal consumption of 301 million short tons with the summer peak consumption reaching 38 million short t in July. Reported PRB deliveries reached 36 million short t with BNSF making up about two-thirds, or 24 million short t of July 2013 deliveries. 

Wood Mackenzie estimates that gas prices may exceed US$ 5.00/million Btu during the same period of 2014 and coal consumption - assuming there are no constraints on production or delivery - is estimated at nearly 370 million short t, peaking at 50 million short t/month in July and August.

"Yet, even if the railroads were able to keep up, it is not expected that the mines themselves could sustain or even attain, a 50 million short t/month rate of production – 600 million short tpa – given recent cuts in operations," adds Preston.

However, it's unlikely that production will be able to get far above 40 million short t/month by the end of the year and will likely languish around the 35 million short t/month level for some time. The last several years saw excellent prices from the buyers' perspective and subpar prices from the producers' perspective.

"The low prices caused a slowdown in capital spending, miner layoffs and equipment mothballing" concludes Preston.

Wood Mackenzie expects a ramp up in production to take more than six months before the PRB basin can produce 500 million short t/year and mentions that other basins are increasing production, but growth in Eastern and Central coal can only make up a part of the lost PRB demand. When power generation levels decline as temperatures cool through the fall, reduced demand for coal and gas will ease constraints on PRB production, and a strong late-season injection should boost inventories to 3.48 trillion ft3, and allow prices to ease back to US$ 4.75/million Btu.

Written by Wood Mackenzie. Edited by Sam Dodson

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